The Ninth Circuit Bankruptcy Appellate Panel recently made a ruling that will protect business owners in bankruptcy from what has long been an injustice. The Court ruled in Sachan v. Huh, 2014 WL 936803 that debts that are the result of an agent or employee’s fraud can be discharged unless the debtor participated in the fraud. Here is why this ruling is important.
I filed a bankruptcy case some years ago for a client who owned 3 convenience stores in Kingman, Arizona. Unfortunately, the bad economy forced him to file bankruptcy due to the large business debts regarding the stores. Normally in a Chapter 7 bankruptcy he would have received a discharge of all of his debts, which would have allowed the client and his family a fresh start. But in this case there was a problem.
In bankruptcy, fraud debts cannot be discharged. This makes sense, as bankruptcy is set up for the poor but unfortunate debtor who incurs debts that he honestly cannot pay. If the debtor has debts obtained through fraud (Ponzi schemes, lying on loan applications, stealing money from his employer), he should not be able to escape these debts in bankruptcy. This is what happened to my debtor in his case. He had a manager who ran one of the stores. Unbeknownst to my client, the manager was ripping off the gasoline company. The manager would order gas for the pumps, divert the gas after delivery to his own personal tanks so he could sell it himself, and then the manager failed to pay the gas company. The manager then skipped town, leaving my client with an unpaid $100,000 bill to the gasoline company.
Clearly, the manager scammed the gasoline company. My client knew nothing about this. When he filed bankruptcy, however, the gasoline company argued to the judge that even though my client had no participation in the scam, he was automatically guilty of fraud, because he was the employer and the fraud of his employee (the manager) counted has his fraud. The bankruptcy judge thought this was unfair, but said he had no choice but to rule against my client, because the law at that time said that the fraud of an employee or agent is always imputed to the principal (owner of the business). Now, thanks to the Sachan case, this legal precedent has been overruled and my business clients can get the fresh start in bankruptcy they deserve without being saddled with the frauds of their employees.
Harold E. Campbell, Esq.